Monday, July 11, 2005

Steve Horwitz is giving his lecture on the Great Depression and how to explain it. He argues (and for me demonstrates) that the GD was essentially a monetary phenomenon. Right now he's giving a really clear explanation of what money is, the functions it serves and what we mean by 'demand' for money. The key point, which noneconomists find hard to grasp is that demand for money is not the same as demand for income but a desire to hold real (but unused) purchasing power.

Steve goes on in his talk to explain how the great depression is a consequence of monetary disorder. Essentially the 1920s are an inflation, disguised by productivity increases as the big innovations of the 1880-1900 period worked their way through the economy. So demand for meoney was low. But in the 1930s, after a catastrophic reduction in money supply by the Fed there was a higher demand for money than there was supply. Hence the GD.

I'm interested in two aspects of the students response. Firstly, will anyone spot or argue that we are currently in a situation very similar to the 1920s? Mervyn King (government of the Bank of England) recently pointed out that UK broad money supply is rising at an annualised rate of 13% plus. There hasn't been a rise in prices (other than for government services) because of globalisation, particularly cheaper manufacturing from China and services from India. The excess supply of money has fed through into rising prices for real assets, hence a whole series of property booms.

Secondly, how will they respond to his iconoclastic take on the history of the GD? In my experience the mythical history of the depression, as a systemic crisis of capitalism that was resolved by FDR and the New Deal has acquired the status of obvious truth. I don't think this is due to historians or academics and their teaching. In fact the economic historians are ever more sceptical of the Schlesinger view of the history of the 1920s and 1930s. The problem is that the GD had a huge impact on the lives of millions of people and as a result the initial explanation (the conventional wisdom as Steve calls it) has become part of the 'folk memory'. Trying to shift popular memory is much more difficult than shifting academic debate. For one thing it doesn't get done by scholarly work itself. Rather you need popular history, which is entertaining and makes the scholarly work accessible . For some reason historians have only recently started to produce works of this kind.

We always want more income, but we don't always want to hold our increased wealth in the form of money. Think of what you do on payday - you take some of your income, which is temporarily all in the form of money, and turn much of it into payment for goods and services. Your demand for money is a demand to hold some of your wealth in the form of "real but unused purchasing power." What you leave in the bank after you pay the bills is your demand for money.

With regard to the statement about the UK money supply's effect on property prices:

Is this intended as an explanation for a real estate boom in the UK, or more generally? Is there an unheralded expansion of the money supply in the US, or does the purported housing bubble require a different explanation?

It was meant as a general observation, although I only have the detailed knowledge of Ireland and the UK, both of which have had substantial expansion of broad money (with low interest rates) and real asset booms. There seems to be a similar process in the US and Australia. The Economist had an article on this a couple of weeks ago.